What California’s climate disclosure law means for building owners.

There is a lot of talk about California’s Corporate Climate Data Accountability Act, SB 253, and there should be. It is an important piece of legislation that should significantly move the needle on climate.

For sustainable building nerds, it’s a really big deal.

Photo by Cytonn Photography on Unsplash

If you are not familiar with SB 253, and related legislation, SB 261 (Climate-Related Financial Risk Act), here is a good summary from Politico, “Taken together, the laws will change the landscape for corporate disclosure. For the first time in the U.S., large publicly traded and privately held corporations doing business in California will need to make public both their impact on the environment, including Scope 3 emissions or those generated through a company’s value chain, and how climate change is impacting their bottom line.”

So what does this have to do with building owners?

One key impact that real estate folks are not talking about: leases will be the lynchpin of compliance with SB 253 and related climate disclosure regulations. Why? Because SB 253 does not waffle on Scope 3 - companies are clearly required to disclose Scopes 1, 2 and 3. And even absent regulation, the market - largely driven by ESG - is demanding supply chain transparency. And hopefully this is obvious, but just because SB 253 specifically applies to companies “operating in California,” (1) what that means is not year clear and (2) the inclusion of Scope 3 means that the impacts will extend far beyond state lines.

This leaves one big question:

How will building owners access to the data they need from their tenants to report, and validate, their Scope 3 emissions?

Generally speaking, the onus of these new climate regulations is on owners. If a tenant does not want to provide necessary information, and the lease does not reserve the owner’s ability to access it, owners are probably out of luck. And even if a lease contains is some general provision addressing data disclosure, specifics like format and frequency should be clarified, to avoid a variety of administrative headaches.

In addition to the importance of including new language, existing, outdated, yet “Standard” lease terms could also prevent owners from meeting climate goals. For example, terms that require the building to have extended “Operating Hours” or specific temperature set points can be problematic from a compliance and energy performance standpoint.

Compounding factors

In addition to climate disclosure rules, California, like a steadily increasing number of jurisdictions, is moving towards a state-wide BPS. Generally speaking, Building Performance Standards are regulatory tools that set energy or emissions targets that must be met over specific time periods. They can take various formats, but they are generally aimed at improving energy efficiency and reducing climate impacts of the existing building stock - something that, from a regulatory standpoint, has never been done before.

And because BPSs are so new, virtually all leases that exist today were written at a time when BPS did not exist; these leases were simply not designed or drafted to manage the impacts of performance-driven regulations - because they did not exist.

And Building Performance Standards are highly data-driven. Owners need to benchmark their buildings to determine compliance requirements (and any necessary capital improvements) both for the initial compliance cycle, and subsequent cycles, which become more increasingly stringent over time.

A lease designed to address these data-driven issues (and others) should, at a bare minimum, provide reasonable owner access to consumption information (whether from the tenant’s utility bills or via sub-meters), and plan for forthcoming issues like water efficiency. Because in these early days of BPSs, we usually think of them as relating to energy usage, this regulatory tool can be applied to any data point that can be measured, and water usage (at least potable water usage) is very likely to be restricted in the near future; or at least, within the length of an average lease.

Risk management

The entire building industry needs to fundamentally rethink leases, and see them as a tool to align owners and tenants towards shared climate goals. Lease language and outdated excuses like the Split Incentive also need to fall by the wayside.

And building industry professionals need to understand that the Split Incentive really doesn’t matter any more; this is because the Split Incentive is predicated on the assumption that an owner needs to be incentivized to make capital improvements or other upgrades related to sustainability, which it generally will not benefit from.

In jurisdictions with robust BPSs, it no longer matters if an owner is incentivized to make necessary upgrades, the legislation requires it. And for the owners who believe they will just “pay the penalty,” many jurisdictions are setting or increasing penalty levels to drive compliance, not fund raising.

The bottom line

Update your leases - now; because clarity benefits everyone. Virtually all leases that exist today did not even contemplate climate disclosure or performance legislation. There is no other context where it would be acceptable to carry on with contracts that were never designed to address current market and regulatory considerations - building operators, owners, tenants, lenders, insurers and commercial brokers need to get in alignment with the current market reality.

Manage the risks of this evolving regulatory landscape by updating your lease language. Given the average length of commercial leases, waiting is a pretty risky strategy. The key is to develop lease language that aligns owners and tenants towards shared climate goals and creates both sufficient clarity and flexibility to accommodate the rate of change in this space.

And if you need support with the latest leasing issues, email us at nicole@climate-alignedlaw.com.

Make it stand out

A very high level overview of the differences between the SEC’s proposed rules and SB 253.

This is common sense, but bears repeating: this blog is intended for informational purposes and does not contain or convey legal advice. The law is inherently fact specific. General information, including this blog, should not be used as a substitute for competent legal advice from a lawyer you have retained and who has agreed to represent you.